Abstract:

In accordance with Basel III Framework, development of the countercyclical buffer requirement was to ascertain that on the whole, banks maintain a capital buffer to protect themselves from probable losses in future. It also ensures that when the entire financial system faces a stressful period of post credit boom, flow of credit in the economy can be facilitated to some extent.  However, when credit risk in lending becomes materialized, it could hardly be attributed to capital shock, which is often related to business cycle. During the times of an economic downturn when counterparties are more prone to be downgraded, a rise in anticipated credit risk is evinced whereas during times of economic boost, it decreases. In this context, the objective of the study is to examine the impact of business cycle fluctuations on Pakistani commercial banks’ capital buffer and portfolio risk in compliance with minimum capital requirements during the period of 2004-2014. The secondary data comprises all commercial public sector, private sector and foreign banks of Pakistan and data has been collected from bank scope data base and State Bank of Pakistan from 2004 to 2014.Simultaneous Equations Model has been estimated by using two step Generalized Method of Moments (GMM).The results show that bank capital buffer fluctuates counter cyclically but business cycle fluctuations have no significant impact on portfolio risk. Our results support for Basel III accord that countercyclical capital buffer is essential for banking institutions during downturn to help the economy. This research will help policy makers to make and implement viable decisions on the optimal capital buffers; policy maker will seize an opportunity to devise strategy accordingly if the bank is shortsighted or a forward looking bank.